Flat Income Taxes Don’t Endanger Public Finances or Create Inequality

May 6, 2014

There is no evidence to suggest that progressive taxes are better for a state's finances than flat taxes, says Lyman Stone, an economist at the Tax Foundation's Center for State Tax Policy.

The Center for Budget and Policy Priorities (CBPP) recently argued that a progressive income tax in Illinois would benefit the state, contending that higher income taxes do not hurt growth and can improve inequality.

Stone responds to CBPP's assertion and combats some of the myths surrounding progressive and flat tax schemes.

It is a myth that progressive income taxes result in lower inequality. In fact, states with progressive income taxes have higher inequality than those with other tax schemes, but in general, inequality does not vary much between the states.

Using the Gini coefficient (which is the most common measure of income inequality) to compare inequality among states with different tax codes, the differences are very small.

And the differences that do exist do not support the CBPP's claims. Instead, evidence indicates that the states with highly progressive taxes actually have higher levels of inequality.

It is also untrue that flat taxes limit a state's ability to cover costs. While CBPP insists that Illinois' flat tax has resulted in limited government revenue, creating budget problems for the state, the flat tax is not the cause of Illinois' problems.

Utah, North Carolina and Indiana are all flat tax states, and each has managed to keep AAA credit ratings and pay their bills.

In fact, the states with no income tax at all have higher average credit ratings than the average ratings for the most progressive income tax states.

Flat taxes do not necessarily cause better credit ratings, but -- contrary to CBPP's assertion -- they also do not cause poor ones. Tax rates and structures, spending policies, federal and state division of responsibilities, and financial management all contribute to a state's financial health.

Mismanagement and overspending are the most likely culprits behind Illinois' financial troubles.